When retiring from a retirement fund a retiree has to purchase an annuity with the compulsory portion of the capital, i.e. that portion not taken as a cash lump sum. The annuity purchase decision is essentially one that is made between a Traditional Annuity and a Living Annuity.
Traditional or guaranteed annuities are essentially a contract between an annuitant and an issuer (usually an insurance company) where the annuitant pays over capital to the issuer in return for a guaranteed flow of future income for a set period and based on upfront parameters. These annuities come in various forms and include: single or joint lives; annual set escalations; inflation-linked or “with-profits” escalations; guaranteed periods and the like. A Living Annuity on the other hand is almost a personal pension plan. The Association for Savings & Investment SA (ASISA) defines a Living Annuity as “a special type of compulsory purchase annuity offered by insurers and retirement funds, under which the income (or annuity amount) is not guaranteed but is dependent on the performance of the underlying investments. It allows the client to select an income level that ranges between a pre-defined minimum and maximum level.”
At the heart of this discussion is the notion that proper financial advice is imperative when it comes to decisions about retirement. This is true in terms of adequate provision leading up to retirement as well as suitable strategies during the drawdown phase itself. Each individual situation is different and demands a distinct solution depending on the circumstances, needs, desires and constraints applicable to the people involved. Choices made must have taken proper cognisance of aspects such as drawing requirements, the appetite for risk, general health, annuity and interest rates at the time, as well as the availability of any other investment capital, assets or income streams.
In the last few years, the South African compulsory annuity market has been dominated by investment-linked Living Annuities, with 85% opting for a Living Annuity when purchasing an annuity at retirement. This is a surprisingly high proportion in a country where a minority have the luxury of reaching retirement with adequate provision. Furthermore, it is likely that many of these individuals cannot afford to take on the risks associated with a Living Annuity purchase (e.g. investment, inflation and longevity risks are not passed to an insurer). In particular, there is a very large risk associated with a high and unsustainable rate of withdrawal from a Living Annuity.
There have been firm policy responses from National Treasury of late. They have issued a number of papers on reforming the retirement industry, including specific focus on compulsory annuities. A number of changes are mooted in an effort to improve the sustainability of income in retirement and thereby avoiding this burden falling on the State. It should go without saying that industry role players need to ensure the matching of client needs and the solutions provided. Changes to the regulatory environment continue, with the abovementioned papers likely to result in new legislation along with the stipulations of the Treating Customers Fairly (TFC) provisions being rolled out. There is a concerted effort to drive appropriate behaviour by retirees, advisors and product providers.
Personal Trust has managed Living Annuities for clients for over 14 years now, with more than R1 billion under management. We think that firstly, we employ the right Trust Officers to provide appropriate financial advice to help clients make appropriate choices. Secondly, if the vehicle chosen happens to be a Living Annuity, we feel we have the asset management capabilities to provide appropriate strategies for defined client profiles. We are proud of our record in helping ensure that clients who have Living Annuities are able to continue to sustainably deal with their retirement needs.
My gratitude to Peter Doyle for his advice and comments.